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Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings1

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Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings1 Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings1 Vikas Agarwal 2 Wei Jiang3 Yuehua Tang4 Baozhong Yang5 ABSTRACT This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases. JEL Classification: G10, G19 1 The paper has benefited from comments and suggestions from Nicole Boyson, Jay Cai, Mark Chen, Conrad Ciccotello, Meyer “Mike” Eisenberg, Merritt Fox, Gerald Gay, Michael Gombola, Jeff Gordon, Laurie Hodrick, Lixin Huang, Narasimhan Jegadeesh, Jayant Kale, Omesh Kini, Chip Ryan, and seminar and conference participants at Columbia Business School, Columbia Law School, Georgia State University, University of Buffalo, All-Georgia Finance Conference, and the Conference on Financial Economics and Accounting at Rutgers Business School. We grateful acknowledge financial support from the Q Group. The authors thank George Connaughton, Bharat Kesavan, Vyacheslav Fos, and Linlin Ma for excellent research assistance. 2 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1207, Atlanta, GA 30303. Research Fellow at the Centre for Financial Research (CFR), University of Cologne. Tel: 404 413 7326, Email: [email protected]. 3 Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 803, New York NY 10027. Tel: 212 854 9002, Email: [email protected]. 4 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1221, Atlanta, GA 30303. Tel: 404 413 7313, Email: [email protected]. 5 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1243, Atlanta, GA 30303. Tel: 404 413 7350, Email: [email protected]. Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases. Mandatory disclosure of ownership in public companies by investors is an essential part of the securities market regulation. At the core of this regulation is the Section 13(f) of the Securities Exchange Act of 1934 that requires institutional investment managers to disclose their quarterly portfolio holdings.6 The quarterly reports, filed to the Securities and Exchange Commission (SEC) on the Form 13F, disseminate the public information about holdings and investment activities of institutional investors. An exception to the rule, however, provides confidential treatment of certain holdings through amendments to the original Form 13F. When adequate written factual support is provided for certain holdings, this provision allows the institutions to delay the disclosure of those holdings, usually up to one year. Throughout the paper, we refer to these amendments as “confidential filings,” and the positions included in such filings as “confidential holdings.” In this paper, we address two issues related to confidential holdings. First, we examine the motives for institutional investors to seek confidentiality. In particular, we investigate if the confidential holdings are information-driven by studying the institutional and stock characteristics associated with such holdings. Second, we estimate the abnormal performance of the confidential holdings, and analyze the cross-sectional variation in the performance of these holdings for different types of institutional 6 Section I.A. contains a more detailed description of the institutional background regarding the ownership disclosure. 1 investors. Our study contributes to a large literature that studies the reported quarterly portfolio holdings of institutional investors to evaluate these investors’ performance and managerial ability, to extract information from the reported holdings to form investment strategies, or to relate institutional ownership to corporate policies and events. However, the prior papers use only the data on original 13F filings, usually from the Thomson Reuters Ownership Data (formerly the CDA/Spectrum database), and therefore ignore the confidential holdings because they are not included in the standard commercial databases. Apart from minimizing price impact during ongoing acquisitions and dispositions, incentives to seek confidentiality most likely arise from private information as perceived by the investment manager. It is in the best interest of investment managers not to disclose their informed positions before they have reaped the full benefits of their superior information. Such incentives are often in conflict with the regulatory rules. For example, Perry Corp, a well-known hedge fund, attempted to keep secret its accumulation of position in Mylan Inc. in 2004 when the company was contemplating a merger with King Pharmaceuticals Inc. The deal ultimately fell through; nevertheless, Perry was under investigation by the SEC on the allegation of improperly withholding details about a large investment in an effort to profit. 7 Though the two parties settled in July 2009, the case highlights continuing tension between the desire of some investors to withhold information that could reveal their investment strategies, and the demand of the public and regulators for transparency. As a matter of fact, several hedge funds and successful investors including Warren Buffett have appealed to the SEC for an exemption from revealing their positions in the 13F forms but have been unsuccessful in convincing the SEC. Philip Goldstein, an activist hedge fund manager at Bulldog Investors likens his stock holdings to “trade secrets” as much as the protected formula used to make Coke, and contends that complying with the 13F rule “constitute[s] a ‘taking’ of [the fund’s] property without just compensation in violation of the Fifth Amendment to the Constitution.”8 In the wake of the “quant 7 For the SEC litigation release of this case, please see: http://www.sec.gov/litigation/admin/2009/34-60351.pdf. Perry was accused of violating the rule regarding Schedule 13D which requires prompt and proper disclosure of positions above 5%. 8 For a more detailed discussion, see Philip Goldstein’s interview in September 12, 2006 issue of Business Week: 2 meltdown” in August 2007, quant hedge funds blamed the ownership disclosure for inviting “copycats” into an increasingly correlated and crowded space of quant strategies, which contributed to the “death spiral” in the summer of 2007 when many funds employing similar strategies attempted to cut their risks simultaneously in response to their losses (Khandani and Lo (2007)). Most vocal among them was D. E. Shaw & Company who demanded confidentiality for its whole portfolio in order to guard its proprietary models, but the request was denied by the SEC. Though confidential treatment is meant to be the exception rather than the rule, some institutional investors seem to have taken advantage of it for the benefit of delayed disclosure. Our study is based on a comprehensive collection of all original and amendments to 13F filings by all institutions during the period of 1999-2007, where the amendments include both approved and rejected applications for confidential treatment. We find that 233 institutions (7.2% of all 13F filing institutions) have resorted to confidential treatment at least once, and the average (median) value of the confidential holdings amounts to 27.3% (12.3%) of the total value of securities included in both the original and confidential 13F
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